Weekend Reading For Financial Planners (June 25-26) 2022

Author: Adam Van Deusen

Team Kitces

Adam is an Associate Financial Planning Nerd at Kitces.com. He previously worked at a financial planning firm in Bethesda, Maryland, and as a journalist covering the banking and insurance industries. Outside of work, he serves as a volunteer financial planner and class instructor for non-profits in the Northern Virginia area. He has an MA from Johns Hopkins University and a BA from the University of Virginia. He can be reached at [email protected]

Read more of Adam’s articles here.

(Mark Schoeff | InvestmentNews)

The Securing a Strong Retirement Act, better known as “SECURE 2.0”, which had been in the works since October 2020, gained significant momentum in March, passing the House of Representatives on an overwhelming 414-5 vote. The legislation includes a variety of measures to build on the popular provisions of the original 2019 SECURE Act, including increasing the RMD age and raising certain catch-up contribution limits, along with other measures. With the passage of the House bill, attention turned to the Senate, which considered and consolidated a number of similar bills.

And now, over the past two weeks, Senate committees have passed a pair of bills that will go to the full Senate for a vote, and could set the stage for passage of a compromise bill with the House by the end of the year. The Senate Health, Education, Labor & Pensions Committee on June 14 unanimously voted to advance the “Retirement Improvement and Savings Enhancement to Supplement Healthy Investments for the Nest Egg”, or RISE & SHINE Act, and the Senate Finance Committee on June 22 unanimously voted to move forward the Enhancing American Retirement Now (EARN) Act. The two bills will likely be combined and reconciled with the House’s SECURE 2.0 legislation before a final bill is voted on by the two chambers.

Key provisions of the EARN Act include raising the minimum RMD age from 72 to 75, increasing catch-up contributions for people between ages 60 and 63, allowing employers to match student-loan payments with retirement plan contributions to a 401(k) plan, standardizing forms for retirement plan rollovers, and allowing workers to take retirement plan distributions to pay for long-term-care insurance, among other measures. The Rise & Shine Act addressed several related measures, including establishing emergency savings accounts linked to workplace retirement plans, allowing multiple-employer 403(b) plans, and enabling more part-time workers to participate in retirement programs, among other measures.

While the measures in the Senate bills are similar to proposals in the House’s SECURE 2.0, the reconciliation process allows for additional measures to be added or removed, so the scope of the final legislation remains unclear. But given the apparent popularity of the bills, the House and Senate will likely look to have legislation ready for a final vote by the end of the year (notably the original SECURE Act was passed on December 19, 2019) to avoid having to reintroduce the legislation in the next Congress next year. Unfortunately, such a late-year passage will make it difficult to take action on the new provisions in 2022 itself, though at this point most of the key provisions of SECURE 2.0 will be more relevant for planning in future years. (And to the extent that there are any late-year planning opportunities that emerge in the final legislation, stay tuned for a Nerd’s Eye View article that will recap them as soon as the legislation is fully finalized in/around December!)

(Kenneth Corbin | Barron’s)

The Securities and Exchange Commission (SEC) regulates a wide range of financial advisor activity, from mandatory disclosures to marketing practices (and everything in between!). Currently, these regulations apply to advisors who are working directly with clients, but the expansion of the number and types of market participants whose decisions affect client portfolios (e.g., index providers [and especially custom index providers] who have to decide what companies will be included in their indexes, or asset managers creating model portfolios that other advisors may rely upon) has raised questions of whether or when these entities are in the business of advice as well.

With this in mind, the SEC has issued a request for comment by August 16 on whether such “information providers” should be subject to any part of the regulatory framework of the 1940 Investment Advisers Act. According to SEC Chair Gary Gensler, the call for comment aims to help the SEC determine when, and under what facts and circumstances, information providers are giving investment advice. Being subject to various advisor regulations could have significant effects on information providers, from whether they need to register with the SEC, to whether they should be subjected to similar codes of conduct, including a fiduciary standard.

Index providers, including MSCI, S&P Dow Jones Indices, and FTSE Russell, have become increasingly influential as index investing has gained in popularity, with funds tracking indices reaching more than $10 trillion in assets under management, raising concerns about how they drive the performance of component stocks based on the selection criteria that triggers which companies are added and subtracted (and also the potential for front-running of trades where providers and personnel have advance knowledge of changes to the index). In addition, the request for comment questions whether clients of an advisor who uses a model portfolio maker could be confused about conflicts of interest, the source of the fees they pay, and who is bound by a fiduciary duty, given that many asset managers pay technology platforms to have their (but not other non-paying) models featured in certain model marketplaces.

So while the comment period remains open, the SEC’s request signals the potential for a dramatic expansion in the types of companies subject to its regulation. For advisors and their clients, this could provide more confidence in the roles and conduct of these providers, and provide greater transparency for advisors about how their platforms are impacting the costs of funds their clients use. At the same time, such an expansion could stretch the SEC’s capacity for inspections, which is already extended given the enforcement needs created by measures such as Reg BI. Which raises the question of whether it is ultimately better for the public to have the SEC stretch to regulate a wider range of companies, or more thoroughly cover a smaller range of firms that are most likely to be engaging in wrongdoing?

(Gregg Greenberg | InvestmentNews)

Advisors can recognize the significant value financial planning can provide, but because financial advice is an inherently intangible service, it can sometimes be hard to make the value more tangible for clients (though the use of deliverables can help!). But a recent survey suggests that advisory clients do recognize the benefits of planning, particularly when it comes to giving them confidence in their financial situation.

According to a recent survey conducted by Allianz Life, 74% of respondents working with an advisor felt confident that they were saving enough in a retirement account while 51% of those who have never worked with an advisor thought the same (though this could be partly an effect of selection bias, with those with more savings being more likely to pay for the services of an advisor in the first place). In addition, 67% of those with an advisor felt confident in finding a balance between saving for retirement and spending to enjoy life now, with 47% of those without an advisor reporting the same. Another significant gap was evident when it comes to making investments less risky, with 57% of those with an advisor feeling confident, but only 25% without an advisor feeling the same.

The survey also looked at differences in priorities for current retirees, near-retirees (those within 10 years of retirement), and pre-retirees (those 10 years or more from retirement). Compared to the other two groups, retirees were more focused on having their advisor maximize investment return, protect investments from market loss, and minimize their tax burden. Near-retirees were more interested in getting help maximizing their Social Security benefits and making the best decisions about Medicare and health insurance, while pre-retirees were more likely to want their advisor to secure their children’s financial future, balance their budget to save for later while enjoying life now, and pay down debt.

Ultimately, the key point is that advisors provide significant value to clients, in part by helping them feel more confident in their financial future and allowing them to make the most of their finances today. And amid competition from robo-advisors, advisors can attract new clients and build client loyalty by focusing on the areas where consumers most value human-provided advice!

(Jack Sharry | InvestmentNews)

While the current bear market has negatively impacted client portfolios, it potentially creates the opportunity for advisors to add value to clients through strategies such as tax-loss harvesting or completing Roth conversions while they are ‘on sale’ during a market decline. But while these strategies might get more attention during a bear market, advisors have a wide range of ways to add ‘tax alpha’ to client portfolios.

One way to generate tax alpha is through appropriate asset location, selecting suitable investments (based on their tax treatment) for different types of accounts that will result in the lowest-possible tax liability. For example, using tax-deferred accounts, such as IRAs, to hold assets that generate significant income (e.g., high-yield bonds) and using taxable accounts to hold assets that generate less income (e.g., growth stocks) can result in reduced annual ‘tax drag’.

In addition, an advisor who wants to make changes to a new client’s asset allocation can consider the tax impact of the sale of assets in the client’s current portfolio to manage the client’s tax bill, as some of the investments could have significant gains or losses. Depending on the client’s situation, this can be done all at once or as part of a longer-term rebalancing plan. This strategy can also work alongside appropriate asset location to minimize taxes for the client.

So while taxes are a fact of life, advisors can add value to clients by generating ‘tax alpha’ through a wide range of strategies. And while strategies such as tax-loss harvesting might get increased attention during a market downturn, getting asset location and rebalancing right can often add significant long-term value to clients!

(Karen DeMasters | Financial Advisor)

The SECURE Act changed the retirement income landscape by increasing the age where individuals have to take Required Minimum Distributions (RMDs) from their tax-deferred retirement accounts from 70 ½ to 72. And the ‘SECURE 2.0’ legislation working its way through Congress could increase the RMD age further to 75. But while individuals might not be required to make distributions from their retirement accounts, strategic withdrawals and Roth conversions from these accounts can be valuable strategies.

An individual’s marginal tax rate tends to change over the course of their lifetime, perhaps starting low early in their career, increasing along with their income, and perhaps declining later on as they shift to retirement. This latter period, where some individuals live off of part-time income or accumulated savings before claiming Social Security and beginning RMDs, can be a useful time to pull money out of pre-tax retirement accounts to reduce the size of the account (and required annual withdrawals) when RMDs begin.

Further, Roth conversions can represent an even more valuable strategy, allowing an individual to move assets from a pre-tax account to a Roth IRA, where the funds can not only grow on a tax-deferred basis, but qualified withdrawals will be tax-free as well. And while the amount converted is treated as ordinary income for tax purposes, individuals (and their advisors) can convert just enough to not put them in a significantly higher tax bracket. For example, a 65-year-old who is working part-time before claiming Social Security at age 70 could ‘fill up’ the 10% and 12% brackets with Roth conversions in the years before Social Security and RMDs begin, when this income could put them in a higher tax bracket.

Ultimately, the key point is that just because an individual is not required to take distributions from their retirement accounts does not mean that avoiding withdrawals is always the best choice. And at a time when the current market environment allows investors to complete Roth conversions at a ‘discount’, this strategy could be an even more valuable tool for advisors to consider for their clients!

(Jeff Benjamin | InvestmentNews)

Direct indexing – buying the individual component stocks within an index rather than a single fund representing the index itself – has traditionally been used as a tax management tool for the most affluent investors (who had the highest tax brackets and could afford to pay the transaction costs associated with trading before the current era of ‘free’ trades). And while the current bear market has created additional opportunities for tax-loss harvesting, direct indexing offers a range of other potential uses as well.

Historically, direct indexing was developed as a means to unlock the tax losses of individual stocks in an index, even if the index itself was up. For example, while a mutual fund tracking the S&P 500 index was up 10% since an individual purchased the fund, some of the component companies within the index had most likely lost value during that time. Direct indexing allowed investors to ‘harvest’ these losses, whereas those holding the index mutual fund were unable to do so (though the value of tax-loss harvesting can vary depending on a client’s circumstances). But direct indexing can also be useful in times like today when the broad market has declined. For example, if the S&P 500 index is down 20%, many of its component companies could be down 50% or more. An individual using direct indexing could sell shares of the companies that have lost the most (‘harvesting’ the losses to offset other capital gains or a limited amount of ordinary income) while holding on to the companies that have gained in value.

But while the potential tax benefits of direct indexing are the most well-known, the strategy can be useful in other areas, including allowing investors to exclude certain stocks from an index (e.g., removing weapons manufacturers from a broader index), letting advisors implement custom investment strategies (e.g., factor investing) at a potentially lower cost than using an actively managed fund, or to build a portfolio around a client’s concentrated position (e.g., removing technology stocks from an index if a client is an executive at a technology company with significant stock options).

In the end, direct indexing offers advisors and their clients a range of potential benefits beyond tax management. At the same time, advisors can consider whether these benefits outweigh the costs of using a direct indexing strategy (both platform fees and the time needed to implement the strategy for each client). Nonetheless, as the feature set on direct indexing platforms increases and costs come down, direct indexing could become an increasingly attractive strategy for a wider range of advisors!

(Chris Cumming | The Wall Street Journal)

Investors who check market results on a daily basis have most likely found themselves frustrated more often than not this year. With both stocks and bonds experiencing significant drawdowns, checking daily market returns will almost certainly increase one’s stress levels. This has led some investors to seek out private-market funds, which, among other potential benefits, do not have the same day-to-day volatility as publicly traded investments.

Private-market funds (e.g., private-equity, private-credit, and private real-estate funds) typically have a long time horizon, often 10 years or more, and do not experience daily fluctuations in price (while their value can fluctuate over time, because they are not actively traded, an investor will not see the changes on a daily basis). These have long been popular with pension funds and endowments (which often do not mind locking up their money for a lengthy period) but have been less popular among individual investors (who might prioritize liquidity).

But amid the volatility in both the stock and bond markets so far in 2022, private-fund managers have seen strong inflows from retail investors, who might be pursuing private-market funds in part to avoid daily price swings and to gain access to the funds’ potential to buy companies at a deep discount. And private-fund managers are meeting this demand by raising new funds, including an increase in the number of mutual fund-like vehicles registered under the 1940 Investment Companies Act.

At a time when stocks and bonds are down, it is only natural that investors might look to alternative investment classes as a way to increase returns and reduce drawdowns. Nonetheless, the unique attributes of private-market investments (e.g., their fees and relative illiquidity) suggest that advisors working with clients interested in private-market funds can play an important role in evaluating whether these vehicles are appropriate for the client given their portfolio and investment goals!

(Larry Swedroe | The Evidence-Based Investor)

When markets are declining sharply, investors have a range of options. Some might see an equity market downturn as an opportunity to buy stocks ‘on sale’, presuming that prices will eventually bounce back. On the opposite end of the spectrum, some investors might choose to sell off most or all of their stocks with the goal of preventing further losses. Other investors (whether strategically or because of inertia) might stand pat with their current asset allocation. But identifying which category a given individual is likely to fall into can be challenging.

To shed light on what kind of investors are likely to ‘panic’, a group of researchers used a dataset of more than 650,000 brokerage accounts (active between 2003-2015) to determine the frequency, timing, and duration of ‘panic sales’, defined as a decline of 90% of a household account’s equity assets, of which 50% or more was due to trades, over the course of one month. The researchers found that the characteristics of those most likely to engage in a ‘panic sale’ include being male, above the age of 45, married, or having a greater number of dependents. In addition, investors who believed they had excellent investment experience or knowledge were more likely to engage in panic selling. And while panic selling could benefit the investor (if the market deteriorates further), the researchers found that the median investor earned a slightly negative return after panic selling.

The key point is that while bear markets are difficult for all investors, certain individuals might be more likely to engage in potentially dangerous ‘panic selling’. Because of the potential for such activity to hinder a client’s long-term portfolio performance, advisors can use tools to gauge an individual’s risk tolerance in order to build a portfolio that gives a client the confidence to avoid panicking when the next market downturn arrives!

(Jane Wollman Rusoff | ThinkAdvisor)

Discussions of asset allocations often center on stocks and bonds, which can be broken down further (e.g. international stocks or corporate bonds) to build a client portfolio. But while stocks and bonds get the most attention, there is a broader pool of assets available to investors that can offer non-correlated returns that could potentially enhance the risk/return profile of a portfolio (particularly in the current environment of high inflation and rising interest rates).

According to Buckingham Strategic Wealth Chief Research Officer Larry Swedroe, private floating-rate debt could be a useful alternative asset. Because of the floating rate, the investment’s yield will increase alongside interest rates (whereas fixed-rate bonds tend to decline in value when rates rise), though such debt is subject to economic cycle risk (as the borrowing companies could be unable to repay the debt during an economic downturn). Other options include commodities, which tend to perform well in inflationary environments, as well as assets that are non-correlated to financial markets, such as structured life settlements, drug royalties, and litigation finance (though these typically come at a cost of reduced illiquidity compared to publicly traded assets).

In the end, alternative assets have the potential to serve as useful portfolio diversifiers, potentially providing positive returns when other asset classes are seeing losses, but it is important for advisors and their clients to consider the risks and fees associated with these investments before diving into a new asset class!

(Larry Cao | Enterprising Investor)

There is a debate in many fields as to whether it is better to be a generalist able to handle a wide range of issues, or a specialist who can dig deep into their specific field of expertise. The financial advice industry is no different, as advisors consider whether it is better to be a generalist offering services to a wide range of clients (making the advisor more able to work with a wider range of clients without being so reliant on any one type) or a specialist serving a focused niche (where the niche advisor has the potential to charge higher fees for a more differentiated and specialized offering that can be delivered in a more scalable manner).

Research suggests that generalists are most successful when the pace of change is not too rapid (and it’s feasible for the generalist to know ‘everything’ important to know about the full breadth of their domain), but that their productivity decreases (and specialists thrive) when the pace of changes accelerate (and it requires more focused domain expertise to keep up with the more detailed and nuanced changes).

Notably, this trend can be seen in the history of the financial advisory industry. For example, at a time when the ‘product’ most advisors sold was a mutual fund or insurance policy rather than the advice itself, generalists made out well. Advisors sought to appeal to the broadest range of prospective clients and find gaps in their financial lives that the advisor’s products could fill. But as the advisory industry has developed, so too have the factors that drive advisors’ success. For example, amid consolidation and new advice offerings from asset managers such as Fidelity and Vanguard (who benefit from economies of scale and a built-in pool of potential clients from their brokerage businesses), it can be hard for a generalist advisor to stand out from the pack as the pace of change has accelerated. Rather, it is the specialist advisors who could see more success going forward, providing a level of service to their niche clientele that larger firms are less likely to be able to provide in a fast-changing environment.

So while it might be tempting as an advisor to appeal to the broadest group of prospects (especially for new advisory firms building their client base!) because being a generalist was quite effective in the product-based, slower-change environment of the past, the accelerating pace of change (both with industry competition, and consumer demands for new and deeper services) increasingly means that serving a niche is becoming the stronger path to not only attract prospects whose needs require specialized knowledge (allowing the advisor to differentiate themselves from better-resourced generalist firms), but also improve the advisor’s efficiency by creating standardized processes for clients with similar needs!

(Tim Denning | Unfiltered By Tim Denning)

If you were asked to describe what makes someone ‘smart’, what would you say? Some people might think of a friend who is a trivia whiz, seemingly able to memorize endless facts, or perhaps a colleague with an advanced academic degree. But Denning suggests that while these factors might have led to professional success in previous eras, a different set of skills is necessary to be successful in the 21^st century.

This new definition of ‘smart’ includes elements of ‘emotional intelligence’, such as self-awareness and being able to ‘read a room’ (the ability to understand body language and facial expressions to know where you stand with your interlocutors). And at a time with seemingly endless information and potential tasks, being able to be more efficient, make decisions quicker, and curate content are valuable skills. Further, as the internet has made it possible to reach a much larger audience than in decades past, strong writing skills are increasingly valuable.

The key point, though, is that these skills can be learned and do not require certain innate talents. For example, using an organized decision-making framework (such as a list of pros and cons) can help you make faster decisions. In addition, seeking out curated content (wink, wink) can help save you the time of sorting through the vast array of available news and information. So while you might have trouble remembering all of the state capitals or the elements of the periodic table, by developing emotional intelligence, organizational, and writing skills, you can improve your chances of finding success in the modern era!

(Lawrence Yeo | More To That)

The American education system is designed for students to gain knowledge as they advance from elementary school through high school and beyond, with the motivation of exposing students to a wide range of subjects to better prepare them for the ‘real world’. And financial planning is no different, as candidates for the CFP certification must complete an education requirement consisting of CFP Board-approved coursework and a bachelor’s degree in any discipline from an accredited college or university.

But just having knowledge is not necessarily enough to be successful in one’s professional and personal life. Yeo suggests this is because knowledge gained through textbooks and lectures is based on someone else’s experience. For example, the authors of a textbook have discretion over which topics to select and how to discuss them. However, Yeo suggests that true understanding can only be gained through personal experience, which allows you to viscerally feel the implications of your decisions and actions for yourself and others.

In the financial planning context, this could be the difference between having the knowledge of estate planning strategies and understanding how to apply them when meeting with a grieving widow. This is why the CFP certification also includes an experience requirement, which helps give consumers the confidence that a CFP professional not only has the knowledge, but also the experience, to handle their needs. And in the end, whether it is through getting a first job at a financial planning firm, completing a financial planning residency program, or practicing the ‘art’ of financial planning through the FPA Residency, there are many ways for aspiring planners to get the experience they need to move beyond the knowledge gained from education programs to a true understanding of what it means to be a financial planner!

We hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think we should highlight in a future column!

In the meantime, if you’re interested in more news and information regarding advisor technology, we’d highly recommend checking out Craig Iskowitz’s “Wealth Management Today” blog, as well as Gavin Spitzner’s “Wealth Management Weekly” blog.